The macho bluster of the US presidential election campaign focused heavily on strength and leadership in a troubled world, but US financial imbalances that seriously threaten not only the US but the global economy hardly rated a mention. While Iraq dominated the election trail, the new US president faces huge current account and budget deficits which are seen as both out of control and potentially damaging in the years ahead.
Financial deficits do not make good campaign rhetoric, but they are issues that cannot be ignored. The former US Treasury Secretary, Larry Summers, stressed at the recent IMF/World Bank annual meetings that the US current account deficit, at over $600bn or 5.5% of GDP, is already at a historic high level, and models suggest it could reach 6.5% in 2006 and 7.8% by 2008. Mr Summers warns, along with others, that the growing imbalance, if left untended, will lead to a crisis.
At present, the deficit is being financed largely by Asian central banks, led by China, which have built up massive foreign exchange reserves approaching $2000bn in the last three years. But Mr Summers asks how long these central banks will continue to buy US Treasury bills earning a relatively small 1.75% return, and what will happen when their appetite for investing in treasuries wanes.
How can the imbalance be addressed? US savings rates have hit an all-time low at 1%-2%, and Mr Summers suggests that the US needs to save significantly more, but only as part of an overall solution. Some predict that a further 20%-30% reduction in the dollar is likely, and economist Fred Bergstein suggests China should revalue its currency by 25%, but Chinese officials appear unlikely to move any time soon on the renminbi.
Meanwhile, the US budget deficit expanded to $412.5bn in fiscal 2004, marking the Bush administration’s second straight record deficit. At 3.6% of GDP, this was the largest since 1993 and larger than 2003’s deficit of 3.5%. Presidential candidate John Kerry has accused President Bush of fiscal recklessness, faulting him for turning the budget surpluses inherited from the Clinton administration into big budget deficits through huge tax cuts.
If these deficits are left unchecked, a severe financial crisis seems imminent with increasing downward pressure on the dollar, upward pressure on US interest rates and the possible imposition by the US of protectionist measures to control imports. The next US administration desperately needs to address these imbalances and global co-operation will be necessary. A new US approach to global finances is essential.
